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The Underlying Mechanics of International Wires / Payments

What is the similarity between International Wire Transfers and Icebergs? For both, you only see a minor part compared to what is below the surface. Whenever you want to send money abroad, you basically either make an order with your bank (or better yet with an FX company), indicating where you want the money sent to, and wait for it to arrive.

Before explaining in details the mechanics on international wire transfers work, let’s go quickly over the basics and ensure that you get smooth introduction into things.

The Basics

When it comes to wire transfers, there are different setups based on whether the transactions are intra-bank, national or international. Moreover, several other elements impact the flow of money including: the currency, the regulation, the agreements between the banks.
Basically, if you are a client of bank ABC and you want to send $10 to a client (your friend Joe) of the same bank, things will be very straightforward. Bank ABC will just debit your account by $10 and credit Joe’s account by $10. There will be actually no physical movement of money and in most cases fees will be quasi-null.

Now, in case Joe is not a client of bank ABC. Let’s assume that Joe is a client of bank XYZ. In case there is an existing relationship and agreement between your banks, the flow will work in the following way:

Bank ABC will debit your account by $10

Bank ABC will credit bank XYZ account by $10

Bank XYZ will credit Joe’s account by $10

Obviously, there being an existing agreement means that Bank ABC has an account in bank XYZ and vice versa. In this particular case, there will be fees applied anytime there is a new credit or debit operation.

Now, in case banks ABC and XYZ have no direct relationship there will be a need for a third party or fourth party correspondent bank. Let’s assume that Bank ABC and XYZ have each a direct relationship with bank TUV. The process will get more complex and will involve more fees and transactions as follow:

Bank ABC will debit your account by $10

Bank ABC will credit bank TUV’s account by $10

Bank TUV will credit bank XYZ’s account by $10

Bank XYZ will credit Joe’s account by $10

So this process can go on forever and can be extremely complex. For this reason, transfers between major banks can be usually done at minor costs, while transfers to remote located smaller banks involve more fees.

But hang on, how do these banks communicate and send instructions to each other?

How to wire money to a bank account?

SWIFT

The swift system enables banks to securely send messages to each to other and implement transfer instructions. So SWIFT is an integrated component of any wire transfer operation enabling banks to effectively communicate. One main drawback of this system is that it is not free of charge and it usually embeds fixed fees (around $10 per transfer).
Now if banks were to pay $10 for each and every debit/credit operation they make – this would amount to billion dollars per year.

The SWIFT system of Bangladesh has been hacked in 2015. It appears the country was using second hand switches and had no firewall in place. The theft yielded the hackers with a billion dollars.

For this reason, banks optimize costs by using parallel systems such as BACS in the UK

BACS

BACS which stands for Banker’s Automated Clearing Services is a “netting system” aimed at optimizing flows between banks. It actually acts like a central clearinghouse that keeps track of all debit/credit operations between banks and only settles the difference at the end of the day. Look at this possible scenario to understand how it works:

Let’s assume that during a given day, Bank ABC’s clients sent $100 million to Bank XYZ’s clients. Within the same day, Bank XYZ’s clients sent the equivalent of $80 million to Bank ABC’s clients.

Basically, the system will net out all these flows and logically instruct to credit $20 million into Bank XYZ’s account held at Bank ABC. By doing so, the fees will be limited and split among all the clients having made transfers. In fact, fees will be quasi null if you opt for BACS processing of your wire transfers – though the transfer will take more time (around 3 days) given that the instruction only gets sent once per day.

Now for those in a hurry and in need to quickly move funds, there are adapted systems that can help you achieve your objective.

Moreover, bacs does not guarantee that banks will actually commit to make the payments. Imagine that bank ABC goes but before settlement… it would have dramatic consequence and Joe would never receive his money.

For this reason, central banks get into the picture.

New On BACS: Customer protection in the UK. If you send a payment via BACS by mistakes you can reclaim your money through noticing the bank; If there were no reclaims, you should be refunded within up to 20 days.

Target2, Fedwire & Chaps

As seen above, central banks enable to avoid all types of risks (liquidity, counterparty). As all banks are supposed to hold accounts with the central bank, the issue related to the existence of relationships among banks disappears – and so does the need for correspondent entities. Each time a transfer gets required, banks would just instruct the central bank to move money from its account into a different entity. So this is exactly the role of entities such as Target2 in Europe (Euro), Fedwire in US ($) and Chaps in Uk (Pound). They allow gross and real time transfer of funds between entities and by doing so, dramatically decrease the time it takes to process and transfer and make it on a real time basis.

On the fees side, it is obviously more expensive that the netting systems, though incentives are provided as transactions size increase. While Fedwire and Target2 seem to be competitive, CHAPS charge tremendous fees (up to £35) for each transaction.

Fedwire Fee System

One Edge – FPS

Introduced in 2008, Faster Payment Services is the latest clearing infrastructure in the UK payment. It completely changed the face of wire transfers by operating on a 24/7 basis and enabling transactions to be made within a couple of hours (and even less at times), and providing flexibility to clients (online, phone banking, branch).

Basically, FPS works pretty much similarly to CHAPS, except that the central bank does not get involved and charges are non-existent (initially, there was an intent to charge anywhere between £1 and 5 by transaction – though none of the banks using this system has been charging customers).

What is important to keep in mind is that FPS only works between member UK banks (as below). So any payment made to a bank account that is not part of the system will take more time and would be potentially subject to charges.

Member Banks

Barclays Bank PLC

Citibank N.A

Clydesdale Bank PLC

Co-operative Bank PLC

Northern Bank Ltd T/A Danske Bank

HSBC Bank PLC

Lloyds Bank

Nationwide Building Society

Royal Bank of Scotland Group

Santander UK PLC

Very interestingly, transaction limits are quite high and can enable both retail and corporate customers to make important transfers on a daily basis. The limits are detailed below for each bank:

No fee but wide bid/ask

Many online forex and wire transfer companies would persuade you to be the best fit by not charging any fee on your transactions. Although that might be true, they would usually apply a wide bid ask spread when quoting for your money exchange operations. So let’s assume that you want to exchange GBP 100k for Us Dollar and let’s assume that the mid price is 1.50. Basically, just by charging a few pips and showing you a price of 1.49, they would instantly make a profit of $1,000.

Obviously the less liquid the currency and the more volatile the market – the wider their quote and the larger their profits…though they would still keep you happy as the transfer fee was waived.

Batches Optimization

As illustrated above, volume plays an important role when it comes to wire transfers – especially if operations do not need to happen in real time. Basically, wire transfer companies would benefit from real time solutions given by Fedwire, CHAPS and Target2, while optimizing the volumes.

This would consist in the following:

The wire transfer company gathers orders

Once a sizeable number is reached, the wire transfer company sends an instruction via Target2 in real time

As we explained earlier, the greater the size of transactions, the lower the fees paid per transaction. So one advice when it comes to making international wire transfers – do not require real time settlement if you want to save costs. That way, you would enable the wire transfer company to do its job and correctly minimize your costs.

This technique mixes the cost advantages of netting (similar to BACS), along to the time & risk minimization advantages of real time techniques.

“The SEPA payments avoid receiving fees in countries that charge them. For example, Spanish banks charge up to 1% to receive funds in, so you might send €100,000 via normal SWIFT TT (the standard international transfer system) and they will deduct €1000 as a charge. This is of course ridiculous, so to avoid them being able to do this we send via SEPA but in tranches under €50,000. These two factors mean the banks are not permitted to take any fees off the transfer. Other countries which do this are Austria, German and Italy that we are aware of, but we send all European payments by this method just in case.

SPEA is a European payment system set up a few years ago and stands for Single European Payment Area.”

Fooling

Some wire transfer companies would tell you that they can transfer your money within minutes. Well, that may be true but what they do not tell you is that you will be responsible for making the transfer from your bank account into their online platform. In this regard, such transfer will take you around 3 days. Now, obviously as you click on the “Send” button, your account will get debited and your balance will decrease – but be aware that a change in a screen’s number does not reflect the actual transfer and availability of money.

One trick you need to be careful about is related to the fact that some would claim that your payments follows a real time procedure while it follows a netting one. So they would charge you high fees – while keeping those fees for themselves and making your transaction follow the traditional / slow path.

Online / Electronic Boost

As clients are e-connected and possess online wallets, it becomes way easier, cheaper and quicker to process international wire transfers. Indeed, the need for turning cash into e-money is removed and the only problematic remaining gets related to changing the numbers. On Paypal for example, you could instantly transfer a payment to a client’s or relative’s Paypal account within seconds. That person could in turn use that money right way in order to make purchases online.

Obviously, if that person wants to turn e-money into physical cash by transferring to his/her bank account – the process would take the usual 2/3 days and follow netting methods.

Put simply, international wire transfers are becoming cheaper and quicker thanks to regulators efforts towards decreasing processing times and costs. It remains clear that international wire transfer companies benefit from these efforts while boosting their business. Now as some of these wire transfer companies diligently enable their clients to benefit from lower fees and greater service, others would just lure their clients while applying disguised fees to their transactions.

Bottom line:

For all these reasons, Yes it is possible to send money cheaper and quicker & Yes, you need to choose the right FX company that will enable you to benefit from all the upsides resulting from technology, innovation and regulators’ efforts.

All in all, there is a lot of movement happening within the UK fund transfer industry and one can only expect things to get quicker and cheaper thanks to the different actors efforts towards liberalizing, opening and becoming smoother.

At MoneyTransferComparison.com, we have tested many companies and we highly encourage you to send your international wire transfer via the following houses who take benefit from the different systems in place in order to minimize time and cost:

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